Uncertain Future for 30-Year Fixed Mortgages

There has been much ado about 30-year mortgage loans lately. Most of the discussion stems from the uncertain future of Fannie Mae and Freddie Mac. If Fannie and Freddie disappear, the 30-year fixed-rate mortgage could disappear with them. If these loans outlive the government-run mortgage giants, they’ll be more expensive and harder to come by. These are the musings of many in the finance world.

Do Fannie and Freddie Sustain the 30-Year Mortgage?

When you look at it from a mortgage lender’s perspective, the 30-year fixed-rate mortgage loan is a flawed product. Lenders that keep these loans on their books are essentially limiting their revenue while increasing their risk. If the interest rate adjusted every few years (like they do in Canada for example), the lender’s revenue would increase with rising rates. But that doesn’t happen with a fixed-rate mortgage. That’s where the “fixed” title comes from, after all.

Granted, most lenders try to sell their 30-year mortgage loans into the secondary mortgage market. And that’s where Fannie Mae and Freddie Mac come into the picture. These government-backed mortgage companies purchase home loans from lenders in the primary market. Then they sell them to investors around the world, usually with a guarantee of payment in the event of default. Lenders offer 30-year fixed-rate mortgages to borrowers, and then they turn around and sell them to Fannie and Freddie. This gives the lenders instant liquidity, while removing the long-term loans from their books.

Future of Fannie Mae and Freddie Mac is Uncertain

Earlier in February, Treasury Secretary Timothy Geithner sent a set of proposals to Congress regarding the future of Fannie Mae and Freddie Mac. Since these organizations are currently in conservatorship, they are being supported by tax dollars (as much as $224 billion by the end of 2012). While Geithner proposed three distinct plans, the long-term goal would be the same — to eventually “wind down” Fannie and Freddie.

So the question is this: If Fannie Mae and Freddie Mac are eventually phased out, how will it affect the availability of 30-year fixed-rate mortgage loans? It’s hard to say, really, because it depends on what emerges in the wake of the phase-out.

Sarah Rosen Wartell, a former HUD official who now works with the Center for American Progress, proposes a hybrid model. Private capital would be the primary means for funding mortgages, while government funds would be used to insure the investments. The government would charge investors a fee for this insurance, which would generate a new source of revenue that’s lacking from the current system.

Others feel the government should get out of the mortgage market entirely. But most people agree on one thing. Without Fannie Mae and Freddie Mac, the availability of 30-year fixed-rate mortgages would decline, while the costs of such loans would rise.

Ellen Seidman from the Office of Thrift Supervision recently told the Huffington Post that the “30-year fixed-rate mortgage is a very difficult product from both an interest rate risk and credit risk perspective … It’s not going to happen without some kind of government backing.”

In a statement released earlier this month, the Consumer Federation of American said the end of government mortgage backing “almost certainly will lead to fewer long term fixed rate mortgages (and) higher prices.” Fair enough. But it’s still not clear what the final plan for dealing with Fannie and Freddie will look like, once Congress weighs in on it. Right now, there are still too many unknowns.

Peter Wallison of the American Enterprise Institute has an opposing view. In his recent article on the Wall Street Journal website, Wallison points out that 30-year jumbo fixed-rate loans are still offered by lenders, despite the fact the government won’t buy or back them. Government backing, said Wallison, “is not necessary in order to make this loan available to homeowners.”

Home Buyers Love the 30-Year Fixed Mortgage

Consumer demand for 30-year fixed-rate mortgages certainly won’t go away. Home buyer love these loans. The longer term reduces the size of monthly payments, while the fixed rate prevents the kinds of surprises inherent with ARM loans. Even if these loans come with additional fees and higher rates, the demand will still be there.

“When there’s demand, people will provide it,” said Brent Ambrose, a real estate professor at Penn State. “It may cost a little more, given that the [government’s] guarantee is not going to be there, but there will be institutions out there that will find a way to provide it.”